Subsidiary

/ March 31st, 2012 / No Comments »

A subsidiary in legal language is most commonly used by reference to company law or public/administrative law.

Company Law

In company law, subsidiary is normally a company that is solely or partly owned and wholly controlled by another incorporated entity (also referred to as parent company or holding company) that owns at least more than half of the subsidiary’s shares with full voting rights. Contrary to common belief, the parent company does not need to be larger in size than the subsidiary company; neither need they operate in the same geographical locations or be involved in the same business activities. Since subsidiary companies are separate legal entities they need to pay their own taxes and take care of their own legal affairs. This can be of certain benefit.

Subsidiary: The Law

Currently, the law states that a company is defined as a subsidiary if another body is a member of the subsidiary company and controls its board of directors and holds more than half in nominal value of the subsidiary’s voting rights. Control of the board of directors occurs when one body can appoint or remove majority of directors without consent from others.

Why use a subsidiary company?

There are both legal and commercial advantages to channelling some work to subsidiary companies. For commercial entities, subsidiaries offer reduction of capital and liability exposure and are extremely convenient when setting up joint ventures and alliances. In addition, having a group of companies means that unless the ultimate holding company is insolvent (and as the holding company is often a non-trading vehicle this is often impossible) assets are ringfenced such that if one subsidiary company is insolvent it does not affect others, so that assets are ringfenced.

Since the subsidiary may be trading under different brand it might engage in more aggressive business activities without directly damaging its holding company’s reputation. Some public companies decide to incorporate privately held ventures.

Practical Examples:

  • Universities – a fair amount of universities in the UK operate as charitable institutions. Therefore, courses and research are entirely charitable non for profit activities. This offers certain benefits such as VAT exemption on fees charged to students and exemption from corporation tax on any profits that are made from the charitable activities. Both, charity and tax law strictly regulate universities in relation to charitable and non-charitable work. For this reason many universities that decide to engage in contract work, such as contract research or other commercial activities where there is a significant risk of loss, decide to incorporate non-charitable companies.
  • Commercial Businesses – operation of subsidiaries is particularly common in the case of large corporate businesses. A recent research conducted by ActionAid reveals that FTSE 100 companies have a combined number of 34,000 subsidiaries with nearly 25% of them being located overseas (mostly in tax heavens such as Cayman Islands). It is important to note that in the UK companies are legally required to disclose their subsidiaries; therefore the number is rather accurate. Subsidiaries offer significant advantages to UK resident companies as being incorporated in foreign jurisdictions (i.e. Cayman Islands) they are regarded as foreign and not subject to UK tax.

Advantages and Disadvantages of Subsidiaries

Advantages

  • Considerable tax advantages for both commercial and charitable companies.
  • Minimisation of potential legal risks associated with new ventures.
  • Convenient form of acquiring new businesses and retaining their entity and internal structure.
  • More flexibility in offsetting profits and losses of different parts of the business.
  • Liabilities and credit claims are locked in that subsidiary and cannot be passed on to the parent company
  • Convenient form of entering into strategic business alliances and joint new ventures with other companies. Through daughter companies, the partners can easily arrange ultimate stakes in the business.

Disadvantages

  • Setting up subsidiaries can be expensive and legally complex.

Although, subsidiary company is separate legal entity and is responsible for its own debts, the parent will often have to cover its debts to protect its own reputation. In addition, if subsidiary is a new company, lenders will nearly always require guarantees from the parent company.

Leave a Reply

*